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IRS OK to Review Electronic Records for Audits

Submitted by admin on Thu, 4/28/2011 - 12:00 am

Future small businesses and self-employed individuals under audit should now be aware of this one, as it will hang all the laundry out there, hopefully the laundry is clean. The IRS is now beginning to request that businesses provide an electronic backup file of their accounting software records for audits of years under examination. The IRS claims that this will:

  1. Reduce the burden on taxpayers and representative because they will not have to print records
  2. Provide a complete set of the taxpayer’s accounting records, decreasing the number of items included in the initial document request, as well as follow-up requests
  3. Increase efficiency of the examiner’s analysis and testing of the books and records

Obviously, there are legal concerns over this that are being challenged, but for the time being the IRS is hanging its hat on this case, United States v. Continental Corporation (1976). Previously, the IRS would identify to a taxpayer which year, and what items are specifically under review, and only request back up documentation for those items.

Now, they are open to evaluate all records in your Quickbooks file, or any other accounting software used, and they would have access to evaluate as many years prior as they wish. Kind of like an open ended audit of your entire books, and all the IRS would need to do is request an audit of one item, during one year, and ask for a back up of your accounting books.

Wow, I’m not really sure how I feel about this, given the current abuses and violation of taxpayer rights we deal with on a daily basis, but the initial impression is that I don’t like it at all from a representation standpoint. Clients who can barely afford audit representation of one year, surely can’t afford the representation of multiple years, which is sure to happen.

The IRS will use Form 4564 (Information Document Request) to request electronic software backup files, and they will request the login information needed to access the data. They state the data should be supplied on a CD, DVD, or a flash/jump drive. The taxpayer is also prohibited from removing prior year data from the electronic backup, essentially only providing the year being audited, but the IRS says this is a no-no.

If the taxpayer or representative creates or reconstructs a new company file, for example, by re-inputting the transactions for only the year under examination, this new file does not satisfy the requirements or needs of the IRS. The new or modified company file is not a copy of the books and records of original entry. The altered electronic file would not meet the requirements of the Information Document Request or a summons and the taxpayer’s representative could be in violation of Circular 230.

I wonder how the tax courts would view a challenge to this if you are providing all pertinent data from the year in question, regardless of the prior case from 1976, as that relates to a time when there were no personal computers and ease of access to reporting.

So, you ask, what if I refuse to provide the electronic accounting file for the entire history of my business when the IRS is only asking for one year? Here is the IRS response:

Under IRC Section 6001 and Regulation 1.6001-1, taxpayers are responsible for maintaining sufficient books and records to support the income and deductions claimed on their tax returns and for presenting this information to the IRS when requested to do so in an examination.

Further, section 7602(a)(1) grants the Service the authority, for purposes of determining whether a return is correct, making a return where none was made, or collecting a liability, to examine any books, papers,records or other data that may be relevant or material to an inquiry.

If a customer declines to submit the requested materials voluntarily, the IRS has the right to summons the information and/or disallow the items reported.

And, what if the taxpayers representative declines to submit the same:

If the taxpayer’s representative chooses to decline to voluntarily submit the requested materials, the IRS has the right to summons the information and the representative could be a violation of Circular 230.

Read the FAQ here, Use of Electronic Accounting Software Records.

I am very interested in seeing how this plays out, as the IRS states that taxpayers and representatives are pushing for this capability, but somehow I’m not sure I completely agree with the IRS, as every representative I’ve spoken to has gasped at this.